Conflicts of Interest driving the downfall of a regulator

A conflict of interest arises when what is in a person’s best interest is not in the best interest of another person or organisation to which that individual owes a fiduciary duty to.

Conflict of interest situations is common in SME where the directors of the company may have an interest as a supplier, customer or in any transaction with the company. The interest of the company director as a supplier with the usual aim of getting the best price and business flow from the company is in opposite to the role that the same person holds as a director of the Company eg to get the lowest price and best deal for the company.

In most conflict of interest situation, typically the main concern would be to ensure that such transactions are at arms’ length and with full disclosure for approval for such transaction by a non-conflicted independent Board. This is to ensure that there is no undue influence exerted by any party with the power of influence on deals transacted against the interests of the Company.

Interestingly, we have seen conflict of interest being discussed not just at the perennial corporate level but at a regulatory level serving the public interest.

The FRC (Financial Reporting Council), the regulatory of auditors in UK has been accused of lack of independence and is an ineffective regulator embroiled in a convoluted web of conflicted interests. The FRC lacked independence because it was not on a statutory footing and lacked direct regulatory oversight over the firms who voluntarily funded it. The FRC is in fact voluntarily funded by the audit firms that it is supposed to exercise oversight and supervision. A clear indication of conflict of interest – you review the work of the people who fund you. A couple of interesting facts were raised in the review by Sir John Kingman on the report on FRC independence:

  • The way FRC was run was more akin to a trade body then regulator
  • Self-perpetuating FRC member appointments largely reliant on the alumni networks and old boys’ club of the largest audit firms – the ones that it is supposed to exercise oversight
  • Inherently and ingrained informal recruitment methods
  • Inaction supervision actions by the FRC on the fallout of HBOS even though it concluded that KPMG’s audit “raised questions about the adequacy of the nature and extent of some of the audit procedures”.
  • FRC’s independence in question when in less than 6 months after its unpublished review of the audit of Patisserie Valerie’s accounts by Grant Thornton, a £40 million fraud was discovered. Clearly now a “review-on-review” is required with FRC marking its own homework.
  • FRC’s Financial Reporting Lab, praised as an example of innovation, lost some credibility when one of its reports on the disclosure of dividends highlighted Carillion as an example of “good practice”. Carillion ended in compulsory liquidation on 15 January 2018 with liabilities of almost £7 billion.
  • Dominance of conflicted parties (Big 4) of the persons that FRC supposed to exercise supervision in the ranks of FRC’s Council and Board.

Several recommendations have been put forth to remove all elements of conflict of interests whether perceived or actual, amongst which is to create a totally new entity the ‘Audit, Reporting and Governance Authority’ (ARGA) to replace FRC. The bad name at the back of conflicts of interest, have generated significant negativity on the reputation of an entity that resulted in its demise. It is paramount that any conflicts of interests issue be managed proactively and do not under estimate the impact that it has on an organisation’s reputation. If that can happen to a regulator, it certainly will on any organisation.